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Thursday, August 22, 2013

Too sensational: The defence of the rupee

                                       Miss Prism: Cecily, you will
read your Political Economy
in my absence. The
chapter on the
Fall of the Rupee
you may omit.
It is somewhat too sensational.

-- Oscar Wilde,
The Importance of Being Earnest,

The graph above superposes the INR/USD exchange rate and Nifty, both reindexed to start at 100 on 15 May 2013. The graph runs till 21 August (i.e. yesterday). The rupee has depreciated by 17% and Nifty has dropped by 13.7%. I feel that the drop in Nifty is substantially about the reversal of reforms of this period. On the exchange rate, I think every short seller of the world got attracted watching the government trying to defend the rupee, which has given overshooting. This problem was exacerbated because RBI had damaged the liquidity of the currency market; when a flood of orders came, the price moved more because the market was shallow.

Here's a kit of readings. By now, almost everyone thinks that the Strong Rupee Policy was a mistake. It's interesting watching people switch positions through this time-line.

And, you may find it interesting to see an updated picture of the evolution of the Indian exchange rate regime [methodology]:

This graph shows a moving window of annualised volatility of the INR/USD exchange rate for the last 15 years, starting from 28 August 1998. Vertical lines show the two dates of structural change of the exchange rate regime. As we see, we had volatility of 1.84% for 4.74 years until 23 May 2003. Then we jumped up to 3.87% volatility for 3.84 years. This lasted till 23 March 2007. We are now in the longest single period under one single exchange rate regime: 6.42 years spent with an annualised volatility of 8.73%. Through this period, every debate on exchange rate policy ended up in favour of exchange rate flexibility. The floating exchange rate is the only stable long-term option for India.


  1. Nifty does not really reflect the mayhem of RBI's moves. Look at the CMIE Banking Index, its down 31% since 15th May 2013 (and 22% since 15th July 2013), thats a third of the mcap weighted banking index! The equal wtd index is even worse!

    RBI has probably ended up doing what the Bank of England did in the 90s, tryin to fight the market, when there is no way you could have in the first place. Bank of England, too raised short term interest rates, but ended up helping the likes of George Soros with billion dollar profits, I am pretty sure this rout would have resulted in many such currency trading heroes for the next decade!

    Eventually, BOE backed off and let the pound depreciate which eventually helped England recover (i.e. lowered inflation in the coming years and improved export earnings, thanks to improved competitiveness owing to current devaluation).

    How difficult was it for the RBI to let the same happen here?

  2. "...Even these metallic problems have their melodramatic sides."

    Loved it. Thanks for the quote. Shows how the more things change, they remain the same.

  3. There is a nice article by Surjit Bhalla in Financial Express:

    It's the interest rate, stupid.

    It seems to me (and maybe I am wrong, what do I know):
    a) that the entire crisis is due to fiscal measures affecting food inflation and lack of clarity at RBI regarding what inflation index it is looking at and targeting and its mismanaging of inflation expectations (rather than the actual interest rate policy).
    b) It seems the gdp deflator is coming down to under 2% while food inflation will be high, probably implying that RBI needed to define a proper index it would target (non-food cpi or something) and use that for monetary policy? That is assuming that RBI/monetary policy can't do anything about food inflation.
    c) cpi is used for wage inflation both in private and public sector and the govt needs to be held accountable for the food inflation part of it. I wonder if the best way would have been to make the gdp deflator be the cpi. Does that make sense? We would be recording -ve growth now and lower growth in the past couple of years if this was done. That would certainly have got the govt's attention.

    RBI could have actually cut rates if non-food inflation has been lower as suggested in the article. But, RBI needed to be clear on its policy objectives 3-4 years back. It needs to define whatever index is appropriate and maintain the credibility of maintaining a target on it. Right now, it seems its all over the place and it doesn't know what it wants to do on inflation targeting, even without the short term measures of the last couple of months.


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